3 Software Stocks to Watch For in a Prospering Industry

The Zacks Computer Software industry benefits from the global pandemic-induced accelerated digital transformation drive. Software is ubiquitous and has become the focal point of technological innovation. Apart from running devices and applications, its usage has been extended to managing infrastructure. The industry is primarily gaining from the ongoing cloud transition. The role of software is constantly evolving. With the continuation of remote work setup and mainstream adoption of the hybrid/flexible work model, the demand for voice and video communication and productivity software is expected to increase exponentially. These trends bode well for industry participants like Synopsys SNPS, Commvault Systems CVLT and DecisionPoint Systems DPSI.

Industry Description

The Zacks Computer Software industry includes companies that provide software applications related to cloud computing, electronic design automation (mostly for semiconductor and electronics industries), digital media and marketing, customer relationship management, on-premises and cloud-based database management, accounting and tax purposes, human capital management, cybersecurity and application performance monitoring and cloud-based enterprise communications platform. Some companies develop and market simulation software (like computer-aided design or CAD, 3D modeling, product lifecycle management or PLM, data orchestration and experience creation), which engineers, designers and researchers use across various industries like architecture, engineering and construction, product design and manufacturing and digital media.

3 Trends Shaping the Future of the Software Industry

Higher Spending on Software Aids Prospects: The industry’s prospects are bright, given higher spending by enterprises on software procurement. Continued investment in big data and analytics and the ongoing adoption of software as a service or SaaS open up significant opportunities for industry players. Cloud offers a flexible and cost-effective platform for developing and testing applications. The deployment time is also much shorter compared with legacy systems. SaaS companies are expected to register strong top-line growth on a higher percentage of recurring revenues, subscription gross margin and a lower churn rate.

Cloud Computing Adoption Gaining Traction: The increasing need to secure cloud platforms amid growing cyber-attacks and hacking incidents is driving demand for cyber security software. Enterprises are focused on rapid migration to cloud and DevOps technologies to achieve scalability and agility for software development and IT operations. This helps in delivering a flawless digital experience to clients. This trend has brought immense value to application and infrastructure performance monitoring. It is driving the demand for performance management monitoring tools that are scalable and suitable for cloud-based environments.

Hybrid Work to Drive Demand But Macro Headwinds a Concern: The mainstream adoption of the distributed workforce model is fueling demand for enterprise communication, workspace management and human capital management software solutions, among others. However, global macroeconomic weakness and geopolitical instability in Europe due to the ongoing Russia-Ukraine war and global supply chain troubles remain concerns. Increasing inflation could affect spending across small- and medium-sized businesses globally. The uncertainty in business visibility could dent the industry’s performance in the near term.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Computer Software industry is housed within the broader Zacks Computer And Technology sector. It carries a Zacks Industry Rank #84, which places it in the top 34{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} of more than 248 Zacks industries.

The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} of the Zacks-ranked industries outperform the bottom 50{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} by a factor of more than 2 to 1.

Before we present a few stocks that you may want to consider for your portfolio, considering bright prospects, let us look at the industry’s recent stock-market performance and valuation picture.

Industry Outperforms Sector But Lags S&P 500

The Zacks Computer Software industry has outperformed the broader Zacks Computer and Technology sector but underperformed the S&P 500 Index in the past year.

The industry has lost 24.1{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} over this period compared with the S&P 500 and the broader sector’ decline of 15.1{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} and 30.6{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847}, respectively.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month P/E, a commonly-used multiple for valuing software companies, we see that the industry is currently trading at 26.32X compared with the S&P 500’s 17.78X. It is also above the sector’s forward-12-month P/E of 21.28X.

In the last five years, the industry has traded as high as 37.28X, as low as 22.63X and at the median of 27.85X, as the chart below shows:

Forward 12-Month Price-to-Earnings (P/E) Ratio

Forward 12-Month P/E Ratio

3 Software Stocks to Power Your Portfolio

DecisionPoint Systems: Laguna Hills, CA-based DecisionPoint provides enterprise mobility and radio frequency identification technologies. The top-line performance is being driven by broad-based strength across several verticals amid global supply chain disruptions. Also, the company’s strong relationships with its OEMs and distribution partners are a tailwind.

Synergies from acquisitions are likely to drive DecisionPoint’s performance. The company concluded two buyouts — Advanced Mobile Group and Boston Technologies — earlier in 2022. These acquisitions boost the company’s position in the lucrative transportation and direct store delivery verticals.

Also, the company completed the re-branding of ExtenData Solutions into DecisionPoint Systems in October 2022. The company was acquired by DecisionPoint Systems in December 2020. The acquisition has helped DecisionPoint to improve its regional presence across the Rocky Mountain and Southwest regions of the United States and expand its professional services team. ExtenData’s MobileConductor delivery management platform has also opened up a new SaaS-based subscription revenue stream for DecisionPoint.

The stock carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The consensus mark for the company’s 2022 earnings is pegged at 36 cents per share, up 50{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} in the past 60 days. Shares have gained 7.7{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} in the past year.

Price and Consensus: DPSI

Synopsys: Mountain View, CA-based Synopsys is an electronic design automation software vendor for the semiconductor and electronics industries. Synopsys is benefiting from strong design wins owing to a robust product portfolio. Growth in the hybrid working trend is driving demand for bandwidth. Moreover, strong traction for Synopsys’ Fusion Compiler product boosted the top line.

Increasing demand for advanced technology, design, IP and security solutions is also creating solid prospects. Moreover, the rising impact of artificial intelligence, 5G, the internet of things and big data is driving investments in new compute and machine learning architectures.

The consensus mark for this Zacks Rank #2 (Buy) company’s fiscal 2023 earnings is pegged at $10.13 per share, indicating year-over-year growth of 13.8{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847}.

Price and Consensus: SNPS

Commvault Systems: Based in Tinton Falls, NJ, provides Unified Data Management solutions for high-performance data protection, universal availability and simplified management of data on complex storage networks. Increasing spending on data protection and other security concerns by business organizations globally is driving demand for the company’s solutions. Transitioning to a subscription-based software business model bodes well for the company.

The company’s top-line performance is gaining from the increasing demand for its software and SaaS solutions. In the last reported quarter, software and products revenue surged 10{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} year over year to $82.8 million, driven by larger deals.

Commvault carries a Zacks Rank #2. The consensus mark for the company’s fiscal 2023 earnings is pegged at $2.68 per share, up 2.7{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} in the past 60 days.

Price and Consensus: CVLT

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